Can a minimum wage increase employment and reduce prices in a neoclassical perfect information economy?

Abstract

This paper investigates the possibility that the imposition of a minimum wage increases employment in the affected sector, measured in terms of hours of work, and lowers product prices. Unlike related prior theoretical research, I consider a neoclassical perfect information economy. Both labor and product markets are assumed to be perfectly competitive. Workers choose the number of hours of work and their effort level. Workers can potentially, but not necessarily, differ in their preferences over income, leisure, and effort. Effort is perfectly observable by the employers. The general framework that highlights the channels through which a minimum wage can increase employment and reduce prices is introduced and necessary and sufficient conditions derived. The paper also develops a number of comparative statics and some illustrative examples. The results provide a simple theoretical foundation that explains some recent findings of the empirical literature on minimum wages. Auxiliary results help explain the effects of minimum wage on the entire wage distribution in a way that is consistent with empirical findings. Finally, welfare analysis shows that worker welfare and employment tend to go in opposite directions; in particular, if employment increases after the imposition of the minimum wage, worker welfare will be reduced, though not necessarily vice versa (the opposite is true for consumer welfare). Strikingly, if a minimum wage increases worker welfare, the chief beneficiaries are not the affected workers but those with incomes that exceed the minimum wage.